First State Bancorp (OTC:FSNM) Q3 2008 Earnings Call October 27, 2008 5:00 PM ET
Christopher Spencer - Senior Vice President and Chief Financial Officer
Michael Stanford - President and Chief Executive Officer
Patrick Dee - Executive Vice President and Chief Operating Officer
Jed Fanning - Chief Credit Officer
Peyton Green - FTN Midwest Research
Bain Slack - KBW
Thank you for standing by and welcome to the First State Bancorporation’s third quarter earnings conference call. At this time all participants are in a listen-only mode (Operator Instructions). Now I’d like to turn today’s conference over to Mr. Chris Spencer, Chief Financial Officer. Sir, you may begin.
Thank you and welcome everyone to our third quarter conference call. First State Bancorporation will provide an online simulcast of this call on our website www.fcbnm.com and an online replay will follow immediately after the call for ten days. There will also be a replay of this call at the toll-free number 866-353-3016.
Your host for the call this afternoon is myself, Christopher C. Spencer, Senior Vice President and Chief Financial Officer; Michael R. Stanford, President and Chief Executive Officer; H. Patrick Dee, Executive Vice President and Chief Operating Officer; and Jed Fanning, Chief Credit Officer of First State Bancorporation.
The Board of Directors of First State Bancorporation have adopted a policy that the company will comply with the Securities and Exchange Commission regulation FD in all respects. Consequently the conference call will proceed under an agenda which I will announce momentarily. The matters outside of this agenda will not be discussed.
The subject matter of this conference call will include forward-looking statements. These statements are not historical facts and involve risks and uncertainties that could cause First State’s results to differ materially from those contained in those statements.
With that, our agenda this afternoon, Pat will lead off with an overview of the quarter, I will then walk through the slides that are available on our website. Pat will make some wrap-up comments and then we’ll open it up for questions from the analysts.
So with that I’ll turn it over to Pat.
Thank you, Chris. This quarter’s earnings results were certainly disappointing but we believe they are far from discouraging. The good news is that in general, non-interest expenses were kept at a reasonable level. Non-interest income was strong in most categories and our net interest margin was fairly steady.
Unfortunately, as we dug a little deeper into our Utah loan portfolio, we found more problems than we previously anticipated. Because of that, we increased the amount that we added to our loan loss provision for the quarter which caused us to report a small net loss, but we are still well capitalized and believe that we are well positioned to move forward in these challenging economic times.
During the quarter, the constant news about the poor national economy and the struggles of financial institutions, many of which were not even banks, have led people to become nervous about the safety of their investments. As a result, our deposit totals decreased during the quarter, but seemed to have stabilized of late especially here in the month of October especially with the recent increases in FDIC insurance coverage.
We are off to a great start with an internal deposit program that we call our extreme bankover and are seeing certain types of deposits increase as a result. We hope to keep that momentum going through the rest of this year.
Asset quality continues to be a challenge, as we saw an increase in our nonperforming assets during the quarter from about $90 million to just over $117 million. The majority of the increase in nonperforming loans came from the Utah market which saw an increase of about $20 million net in nonperforming loans.
We announced in early July that we’re exiting the Utah market, so we’ve taken a more conservative view of some of the loan relationships there. Because the majority of the loans in that market are construction loans, we have also felt the impact of the softening residential real estate market there.
The magnitude of the increase in problem credits in Utah is not a trend that we would expect to continue, as much of the current quarter’s increase came from a more conservative view of individual credits rather than a deterioration in the market; however, we would not expect problem asset trends to flatten out just yet in Utah or our other markets.
We’ve had three consecutive quarters of substantial increases in nonperforming loans and we believe that we’ve now identified the vast majority of the more seriously troubled credits, the majority though not all of these continue to come from our construction and land development portfolios.
We do continue to see good movement in reducing certain nonperforming loans as there is a steady albeit slow sales activity in each of our markets. We’ve increased our allowance for loan losses from 2.17% of loans at June 30 to 2.49% as of the end of the third quarter.
Our charge-offs were somewhat higher during the quarter and year-to-date now total about 58 basis points of average loans on an annualized basis. Our slide show will give a breakdown of our nonperforming loans by general loan category and also by state.
Our OREO portfolio still includes about $6.4 million in carrying value of former bank premises for land that we acquired for future branch sites, including $4.2 million in carrying value of the Heritage Place property. There was one piece in Albuquerque valued at $1.7 million that was sold in September.
One factor which we believe will allow us to significantly bolster our capital ratios is the recently announced program for the US Treasury Department to provide additional capital for banks such as ours. The terms of this capital are very favorable in today’s capital markets and should give us more than enough capital to weather the challenges we think we will face in the next year or so.
We have already applied through the program for a substantial amount capital and are optimistic that we will receive that funding prior to year-end. The amount we have applied for would put our total risk-based capital above 13% and well beyond the 12% capital level that we previously agreed with our regulators to achieve.
Now Chris will run through some of the details on our results for the third quarter and then I will come back and summarize a few thoughts.
Thanks Pat. For those of you that have our slides up and on the website, I’ll go through those. I’ll start with the total assets slide. Total assets increased a nominal $4 million in the quarter with the increase in loans offset by small decreases in cash and investment securities.
Total loans increased $31.4 million in the quarter which is a 4.6% annualized growth rate, which is down significantly from the $119.4 million increase in the second quarter. Our objective has been to slow the growth in the loan portfolio and shrink the balance sheet to strengthen capital ratios. We anticipate that total loans will be flat to lower in the fourth quarter based on selective lending and possibly selling parts of the portfolio at par.
Taking a look at the portfolio by state, geographically loans are higher in each of our states in the quarter, with the largest percentage increase coming from Arizona which also has the smallest percentage of problem in nonperforming assets. While the Utah portfolio is up slightly from funding existing commitments, lending to new customers have stopped and the two branches in Utah will be physically closing this week.
Total deposits, this quarter we experienced a decrease in our total deposits by $149.6 million or 6% as depositors in our markets became concerned about the safety of banks in general. The majority of the decrease came in the month of July and moderated during the remainder of the quarter. The decline in deposits was experienced fairly deeply among all of our markets and across most product types. Broker deposits were increased by approximately $25 million in the quarter to an ending balance of approximately $47 million in September 30.
By state, the largest percentage declines were experienced in Utah and Colorado. The significant decline in Utah was driven by our announcement to exit that market. Our non-interest bearing deposits experienced a similar decline as deposits in total.
Looking at the non interest bearing deposits by state, three of our four states saw declines in non interest bearing deposits with the exception of Arizona which has grown deposits in total year-to-date by $17.8 million or 12%, a 15% annualized growth rate.
Looking at our quarterly net income and earnings per share, the bottom line for the third quarter was a loss of $1.8 million or $0.09 per share. The loss was driven primarily by the $15.6 million provision for loan losses. While this provision was much larger than we had anticipated, it was substantially lower than the $28.7 million recorded in the second quarter and the $1.8 million loss is a significant improvement from the $10.8 million loss excluding the goodwill write-off recorded in the second quarter.
Other significant items which impacted the third quarter include the additional write-down of the Freddie Mac preferred stock by $565,000. The original recorded value of the Freddie Mac stock was $953,000 and now has a carrying value of $55,000.
We also wrote down our one owned branch banking facility in Utah by $365,000, based on a preliminary offer we received from a potential third-party buyer for that building. In addition, we incurred a slightly higher level of marketing expenses in the quarter related primarily to a new lineup of retail banking products that Pat referred to earlier.
The effective tax rate for the quarter was somewhat abnormal where the quarter resulted in a benefit rate of approximately 72%, with results primarily from a static level of permanent tax differences on a very small book loss. Going forward, on normalized earnings that tax rate would drift back toward 35%.
Our quarterly net interest margin, the net interest margin compressed in the quarter by 9 basis points from the second quarter driven almost entirely by the reversal of interest on loans which went on non-accrual status. We anticipate the margin will continue to compress in the fourth quarter primarily from the 50 basis point Fed rate cut earlier this month and that would be affected by as much as 15 to 20 basis points depending on how much we can offset this with decreases in deposit rates and lower borrowing costs. The compression will be even greater if the Fed drops the target rate within this week, which we are anticipating they will.
Return on average assets and return on equity are both negative for the quarter given the loss; however, they are improved from the second quarter. The efficiency ratio for the third quarter was 71.7% and has improved in each of the last two quarters. We continue to make progress in controlling non-interest expenses.
Salaries and employee benefits, the single largest component of non-interest expense, has been declining all year on lower headcount. We have seen improvement in non-interest income primarily in service charge income, but this has been softened by the other than temporary impairment charge taken on the Freddie Mac stock and lower gains on the sale of loans. Mortgage loan sales in the third quarter totaled $56 million compared to $76 million and $84 million in the second and first quarters respectively.
As Pat indicated earlier, our nonperforming assets increased by $27.9 million in the third quarter influenced heavily by the Utah loan portfolio. OREO remained fairly stable with the small increase of $300,000. We continue to be able to move properties out of OREO after they go in. Significant activity in the third quarter includes the sale of a parcel of land previously held for branch expansion which was carried at $1.7 million that Pat referred to earlier.
Looking at the detail of our nonperforming loans reveal that 25 of the $28 million increase in nonperforming loans in the third quarter was in the real estate construction category, with a slight decrease in the commercial C&I. Arizona continues to have the lowest level of nonperforming loans and the remaining states of New Mexico, Colorado and Utah now have roughly equal dollars in nonperforming loans given the significant increase experienced in Utah this quarter which increased by $20 million over the second quarter.
The construction loan portfolio has decreased in total dollars by $37 million since June 30 and has decreased ratably throughout our footprint. Exposure by type of construction also remains fairly consistent from the prior quarter. Loan delinquencies are down for the second quarter in a row from a recent high of 1.31% of total loans in the first quarter to 1.06% at September 30. While we can’t predict this'll be an ongoing trend, we are encouraged by the decline.
The allowance for loan losses ended the quarter at $68.4 million and the increase of $9.4 million and represents 2.49% of loans held for investment at September 30; and 67% of our nonperforming loans. Net charge-offs for the third quarter totaled $6.2 million with the largest amounts coming out of Utah.
On increased charge-offs in the quarter, the percentage of total average loans has increased to 58 basis points on an annualized basis. While this is significantly higher than we have seen in the past several years, it is not at a level that we can’t withstand at this point. As I mentioned earlier, our provision for the quarter was $15.6 million, significantly reduced from the $28.7 million recorded in the second quarter and the main driver for our small loss in the quarter.
With that, I’ll hand it to back to Pat for some concluding comments before we open it up for your questions.
Thank you, Chris. At this time, we continue to pursue the sale of certain performing loans, primarily from our Colorado and Utah marketplaces and we do hope to have some of those finalized during this quarter. The capital that we believe will be available to us under the TARP program should help improve our capital ratios to very strong levels.
Because of the continuing challenges in our loan portfolio, we expect to continue an elevated provision for loan losses such that we will likely either show very small profit or perhaps even a small loss for the next few quarters. Nonetheless we continue to be able to exit many of our problem credits without incurring a substantial loss.
During this quarter we once again added to our allowance for loan losses and believe that we are adequately reserved for the potential loss in our portfolio. The economy and most of our footprint is still generally better than the country as a whole and is evidence by our lower than average unemployment rates, steady job growth and general economic activity.
The additional capital that we believe will be available under the TARP should give us the support to allow us to continue to build our franchise as we go forward. Our management team is extremely capable and remains focused on the tasks at hand.
With that, we’ll open it up to questions from our analysts.
(Operator Instructions) Your first question comes from Peyton Green - FTN Midwest Securities.
Peyton Green - FTN Midwest Research
I was wondering if you could comment on the overall mix of the construction and development book as of September 30. It seems to have declined on a linked quarter basis and then secondly, the commercial real estate side seemed to grow pretty nicely. What kinds of deals are you all doing on the commercial real estate side?
On the construction portfolio, the mix is pretty consistent with what we’ve seen in prior quarters with most of the categories, especially the one-to-four-family coming down during the end quarter. We are continuing to see some pretty significant payoffs; although we are seeing continued funding of prior commitments that we put in place, even in Utah earlier this year. So the overall makeup of that construction portfolio really hasn’t changed although the total is starting to come down and we would expect it to continue to go down in the quarters ahead as the activity there is generally slow.
Commercial real estate, both in our regular portfolio and even in the construction loan portfolio, it continues to be fairly active for us. Certainly we’re seeing less loan demand right now in that area and on the construction for commercial real estate, most of the volumes that we’re seeing are just funding of previous commitments that we made, but the overall commercial real estate portfolio continues to be very healthy for us.
We are seeing a substantial decrease in new projects coming online in just about every one of our markets. We feel like we’re seeing pretty consistent and reasonable vacancy rates and lease rates which lead us to believe that we are not going to see a significant change in the performance of that commercial real estate portfolio.
I think the types of deals that we have done recently have been pretty consistent with what we have done in the past. About 65% of our commercial real estate portfolio is owner occupied. The investor owned portion of that portfolio however does continue to perform well for us with again pretty strong vacancy rates and maintaining good lease rates in most of our markets. So our issues continue to be not exclusively, but primarily with our one-to-four-family construction portfolio.
Peyton Green - FTN Midwest Research
Okay and then specifically out of the $117 million or so on NPAs plus 90’s, how much of that is related to C&D and then how much of the potential problem loans are related to C&D?
Out of the total non-performing, the non-performing loans are right at $100 million basically. 77% of that roughly is out of the construction portfolio and almost all of that is one-to-four-family. Some of that is vertical construction that has been completed. Some of that is out of the A&D portfolio.
At this point there’s actually probably more of it that’s from the vertical construction piece, but there’s a fair amount of bulk in that category. So we are continuing to see especially in terms of the new loans hitting non-performing; for example in Utah, we had three construction A&D loans that hit non-performing during the quarter that were of a significant size. Two of those were in round figures $7 million to $8 million apiece.
One of those was a town home project in the heart of Salt Lake. Another one was a homebuilder; virtually all of that homebuilder relationship was actual vertical construction. Another homebuilder close to about a $5 million relationship in Utah was one of the other main additions there.
So again the problem credits, certainly not all of them, but a vast majority of them continue to come out of the construction loan portfolio and it is somewhat split but still a little more heavily weighted towards the vertical construction as opposed to the A&D piece of that.
Peyton Green - FTN Midwest Research
Does that make you more optimistic about the loss content on the NPAs going forward as you move your way through them or is it too early to tell?
Generally, I think that’s true. What we’re seeing in general across our markets is continued sales activity even in Utah where we’ve seen a large increase in non-performing. There is pretty good sales activity in most sectors of that market. There’s a few of the outlying areas where the sales volume has slowed pretty dramatically, but the majority of the projects that we’re involved with do have some level of sales activity.
One of our larger charge-offs during the quarter was a write-down of about $1.2 million on a land development deal in the Utah market. That is one of our larger losses to date and I think long-term we would expect to see and historically we have seen and we would except to see going forward a higher loss content on the acquisition and development piece of the loan portfolio as opposed to the vertical construction.
We’re going to continue to watch that as we go forward, but again our markets are generally faring much better than many parts of the country and that there is a reasonable level of sales activity although we are starting to see some of those prices decline especially for example in the Utah market.
Peyton Green - FTN Midwest Research
Okay and then out of the potential problem loans, any idea of how much of that was C&D?
We probably have again a pretty similar mix in the potential problem loans. We’re close to 75% of that. 70% to 80% let’s say comes from the construction portfolio and again the vast majority obviously is the residential construction piece.
At this point we probably see a little higher percentage of vertical construction loans as opposed to A&D that are in that potential problem loan mix. Although I think with time we’re starting to see a little bit more of a shift towards the acquisition and development piece of it, but again 70% to 80% of those potential problem loans continue to come out of the construction portfolio.
Peyton Green - FTN Midwest Research
Okay and then last question and I’ll wind up for someone else. In terms of your outlook, in terms of raising capital before, the possibility of the TARP, you all were thinking about shrinking the balance sheet to some degree; is that still somewhat the focus given the underlying economy. Any color that you can provide on loan growth going forward and also is there any hope for deposit growth going forward.
I think in addressing the loan growth issue, we’ve seen a steady shrinkage in the construction totals over the past quarter. We certainly expect that to continue and we think based on current loan requests and our pipeline that we ought to see a gradual decrease in loan totals over the next couple of quarters as a result of that.
We are still optimistic that we’re going to be able to sell some loans that will help us shrink the balance sheet a little bit as well. One of the issues that we are trying to address there is to get a little bit better liquidity as well as the benefit of shrinking the balance sheet and improving our capital ratios.
Our deposit growth we really believe is stabilized now and we think we can get back to a normal although probably fairly slow deposit growth going forward. We think the third quarter was a bit of an aberration for a variety of reasons and we think in our marketplaces especially with this new deposit development program, that we can get back to some reasonable deposit growth in the quarters ahead.
Your next question comes from Bain Slack - KBW.
Bain Slack - KBW
I had a quick question on the OREO. I think you made a comment about the market seems to be available to sort of move these assets sort of out as fast as they are coming in. I wondered if you could give a little bit more color on that and I guess looking into the next couple of quarters, do you see that you’d be able to maybe start pushing them out faster than they are coming in.
I would say in the near-term we’re probably not likely to see us move those out quicker than they are coming in, but I think the one thing that has helped us quite a bit is that by and large our borrowers have been able to resolve some issues with these nonperforming loans before we actually have to go through the foreclosure process.
We still have some of those obviously that the borrowers are not able to continue to generate sales activity and reduce the nonperforming loans, but the good part of that is the activity going into other real estate has been relatively minor, but I don’t think it’s realistic to expect that that situation is going to improve.
We think going forward with that the level of nonperforming loans where they are right now that with time we will probably see a little bit of a shift into where a larger percentage of the nonperforming assets are in OREO and slightly less in nonperforming loans, but right now we are seeing good sales activity.
Again pretty much across the board there are some exceptions to that, certain submarkets within in particular. The Utah market are getting very slow, a few areas in the Denver or Colorado region are quite slow, but even in those slowest markets we’re generally still seeing some sales activity.
Bain Slack - KBW
Okay and I guess looking at the loan balances, I just want to kind of follow up on the question before; I think before you all had given sort of a range that if I’m not mistaken, loans would be down, would be flat I think in the third quarter and then I think down and I can’t remember the exact dollar amount you’ll had previously said, but I was just wondering, when thinking about that I know you’ll have the loan portfolio that you’re putting up for sale, but I guess ex that activity looking at it now, where do you all see that sort of end of ‘08 and then if you could look out further sort of end of ‘09 I guess with everything that’s in place, not including the loan sale.
We did say previously that we thought the third quarter would be pretty flat in terms of loan growth. We ended up with about $30 million increase in loan totals during the third quarter. So it didn’t slow down quite as much as we had originally anticipated, but at this point in time, we’re seeing very steady loan numbers that we think are going to then start to trend downward in the remainder of the fourth quarter. We have got some payouts coming that we think will help in that process. So absent a loan sale, we’ll probably see only fairly nominal decrease in total loans outstanding in the fourth quarter.
Looking into ‘09, it’s really going to depend on a couple of variables, primarily how many opportunities there are in our marketplaces to generate new loan volume that makes sense. Clearly we’ve seen a drastic decline in the demand on the construction side and that is going to continue. So the construction book clearly is going to continue to decline at a pretty steady rate.
One of the government principles in providing this TARP money is that they want to put it out into institutions that are prepared to lend in their markets and we think our markets are probably going to be better suited to that than many parts of the country, although clearly our loan mix going forward is going to be significantly different and underwritten even more conservatively than it was in the past.
So we’re not certain what the opportunities will be for loan growth next year, but we would expect probably a very, very modest increase in loan volumes next year assuming that we are able to accomplish some of those loan sales this year. Yes Mike.
I think one or the other positions around regularly slow growth or we even reduce is more around adhering to the standards we’re setting around concentrations and bringing those into line. So I would expect through new activity and then bringing concentrations under certain categories into conforming areas that we’ll see some new activity around certain type of lending, but we will see an overall shrinkage and I think we ought to still shoot for $100 million to $150 million to create that extra room for us on capital going forward.
One of the things that help us in that process is just the regular amortization on our commercial real estate permanent portfolio and those payments provide us probably a minimum of $10 million to $15 million per month in principal reductions and that’s one of the things that will help us keep that loan growth either at a very nominal level or perhaps even help us show some decline. So the construction portfolio pays off more in chunks as we go, but that amortizing portfolio gives us some cash flow to work with as well.
Bain Slack - KBW
I’m sorry; did you say 15 per month?
Yes, about $10 million to $15 million per month.
Bain Slack - KBW
Okay, this is the last question. I guess is there any color on the loan sale in the process that maybe you can give us what the environment looks like for that?
We’re still very optimistic that we can get a reasonable level of loans sold in the fourth quarter. We’re talking to an institution that picked up some deposits out of failed banks in the western part of the US and we continue to work with them and are pretty optimistic about what we’re being told about the approval to purchase those loans and the movement through their process.
So we can’t count on it until it’s done but at this point we’re very encouraged that we’re going to be able to continue to work with them and sell some loans. These are high quality performing credits that we believe will be purchased either at or very close to par, so there’s no discount involved in selling those.
Thank you. At this time I would like to turn the call back over to the First State Bancorporation management team for closing comments.
We certainly appreciate your time and attention today. These are very challenging times for banks in general and certainly we’ve seen our fair share of challenges this year.
We have had steady increases in our nonperforming loans throughout the year. We’ve spent a lot of time analyzing those trends and believe that we understand what’s impacting our asset quality and are working very hard to limit those increases going forward. The steady activity that we see in reducing already identified nonperforming loans we think will help us control the amount of those increases going forward. Clearly the government capital under the TARP program will help get us over the hump on a couple of fronts.
Number one, give us the capital to help work through the challenges that we're seeing right now and it also gives us the opportunity we think to take advantage of some of the disruption that we’re going to continue to see in our marketplaces as banks have problems and we think we can attract some very good long-term customer relationships out of that. So we see this certainly as an opportunity that comes at an ideal time for us to get our capital ratios back to a level that makes better sense going forward for us.
We are certainly working very hard to get our stock right stock price back up. We think the market continues to discount much more heavily than it deserves, based on our tangible book value and what we think is a very adequate allowance for loan losses.
Again, we appreciate your time and attention today and we will look forward to continuing to report to you in the future hopefully with little better results in the quarters ahead. Thank you.
Thank you everyone for participating in today’s conference call. You may disconnect now at this time.
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